Stock market on January 18, 2018: outlook

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Thoughts

The S&P continues to gap up. This is not a bearish sign.

Initial claims just made a new low today.

Global inflation is on the rise. This is bullish for stocks.

Why VIX is not a useful indicator for the U.S. stock market.

3 pm: the S&P 500 continues to gap up

Approximately 1/3 of the S&P 500’s gains over the past year came from gap ups (i.e. today’s OPEN > yesterday’s CLOSE).

Bears think this means that the central bank is buying stocks on overnight low-volume to push up stock prices. They see this as a sign of a “rigged” market. Here’s what I think.

The Federal Reserve has better things to do than micro-manage the stock market on a day-to-day basis. The Fed’s mandate is to prevent crashes. They don’t care about pullbacks and normal corrections.

The Federal Reserve has openly stated its concern about “frothiness” in financial markets. Why on earth would they add fuel to the fire by pushing stock prices even higher?

Gap ups are completely normal during rallies within bull markets. There’s nothing bearish about this. In fact, this was a very common pattern in 2013. In 2013, the S&P would often gap up by 5-7 points, swing flat during the trading day, gap up again, swing flat during the day, gap up again…. There was nothing bearish about that. The U.S. stock market soared nonstop from 2013 to September 2014.

The gap up just means that European and Asian investors/speculators are buying into the U.S. stock market. They tend to be a little late to the party, which is why gap ups are common during the second half of a rally.

3 pm: Initial claims just made a new low today.

Initial Claims data was released today. It made a new low in this economic expansion.

This is a medium-long term bullish factor for the U.S. stock market. Historically, initial claims tends to rise before bear markets and recessions begin.

I expect Initial Claims to bottom in 2018 or 2019 and then rise 1 year before the next bear market and recession begins.

8 am: Global inflation is on the rise. This is bullish for stocks.

This chart illustrates inflation in 12 major developed markets. Notice that inflation is rising across-the-board.

I expect inflation to rise during the final 2-3 years of this equities bull market. Oil prices are slowly heading higher and the U.S. economy will mostly likely overheat (U.S. unemployment is almost at NAIRU). These factors will propel inflation higher.

Historically, rising inflation is bullish for nominal stock prices. It’s stagflation that’s bearish for stocks. As long as inflation and economic data move higher together (e.g. right now), that’s bullish for stocks. We are now in the early-middle stages of “reflation”.

VIX is the volatility index. It measures downside volatility AND upside volatilty.

Upside volatility for the S&P 500 is usually flat. The S&P rarely goes parabolic on a log scale.

VIX went up while the S&P went up because investors and traders expected upside volatility to surge. In other words, traders bought a ton of calls in anticipation that the pace of the S&P’s rally would increase!

And indeed, the S&P has gone parabolic recently. Even on a log scale.

This is why VIX isn’t useful for predicting S&P 500 corrections. VIX doesn’t just measure downside risk. In times of market euphoria, it also measures upside risk. And VIX can’t tell you when that euphoria will end.

Outlook

The S&P will make a small 6%+ “small correction” in Q1 2018. The current rally is the longest one in history without a 6%+ “small correction”.

The S&P 500 will close higher at the end of 2018 vs the beginning of 2018.

I do not use my discretionary outlook to trade. I remain 100% long UPRO because my Medium-Long Term model does not foresee a significant correction at this point in time. I ignore small corrections. I only sidestep significant corrections and bear markets.

I have been 100% long UPRO since September 7, when the S&P was at 2465 and UPRO was at $109.3

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